Research

A seat at the table: Diversity on boards

Shareholders, interest groups and governments have called increased diversity on boards of directors, but what actually happens when women and minorities take seats on boards long dominated by white men? A team of researchers from the W. P. Carey School set out to explore these issues by studying 12 years of data on the memberships of boards of directors of Fortune 500 companies.

2014-12-03

In the United States and around the world, the movement to increase diversity on corporate boards is growing. Shareholders, interest groups and governments have called for boards of directors to include more women and racial and ethnic minorities in an attempt to bring fresh perspectives to companies and to reflect the diversity of society.

What actually happens, though, when women and minorities take their seats on boards long dominated by white men? Do these new members steer boards in new directions? Are diverse boards more likely to challenge the CEO?

Or is it possible that demographically different directors have little effect on existing boards and companies? Since their numbers are relatively small on boards, could women and minorities be marginalized, or could they be co-opted and captured by the old guard?

A team of researchers from the W. P. Carey School set out to explore these issues by studying 12 years of data on the memberships of boards of directors of Fortune 500 companies. The researchers analyzed the demographics of new and old board members and also followed the career paths of new directors, as well as policy directions of companies.

Their conclusion: Demographically different directors can have an important impact on corporate boards. Non-traditional directors often make boards more independent of CEOs and more likely to curtail CEO pay.

But women and minority directors are more likely to make their presence felt on boards if the new members share certain traits with existing board members, the researchers found. For example, a woman joining an all-male board would likely be more effective if she attended the same college as one or more of the incumbent directors.

"Differences across human beings exist in many dimensions, and as long as new directors share some characteristics with existing board members, the new members will be more readily accepted and will be more likely to succeed on a board," said Amy Hillman, management professor and dean of the W. P. Carey School. "Boards need to get it right: If you are going to get diversity that goes beyond the symbolic, new members have to be integrated into the group."

The study is detailed in the article, "Recategorization into the In-group: The Appointment of Demographically Different New Directors and Their Subsequent Positions on Corporate Boards," published recently in the journal Administrative Science Quarterly. The study's co-authors are Assistant Professor of Management David H. Zhu, Associate Professor of Management Wei Shenand Dean Hillman.

One of the findings of the study is that adding more women and ethnic minorities to boards can have the effect of reducing board diversity in other areas, according to Zhu. "The appointment of minority directors will increase diversity on some dimensions but at the same time increase homogeneity on others," he said.

Pressure for change

For many years, white males dominated the membership of boards of directors in the United States. With the civil rights and women's movements, that began to change. As women and minorities moved into new positions throughout society, pressure began to build for change in corporate boardrooms.

In some European countries — including Norway, Belgium, Italy and Spain — corporate boards are now required by law to fill gender quotas. In the United States, there are no legal requirements for board diversity, but large institutional investors, as well as rights groups, have pressured companies to add women and minorities to boards.

The global financial crisis brought new calls for change. In the aftermath of the crisis, critics contended that corporate boards had been too cozy with chief executives, who led some companies to ruin.

"The diversity of backgrounds on boards of directors has been a major issue, in part because diversity on boards of directors is believed to influence whether directors can draw from perspectives that are different from top management and whether they can see things differently from the CEO," Zhu said.

Said Hillman, "There is a belief in our culture that diversity on boards is a good thing. This has been reinforced by institutional investors and the media pressuring firms for diverse boards."

“Given the external pressure to increase board diversity, it is important to understand how firms select demographic minority directors and to which degree these new demographic minority directors can influence board decisions. This is a primary motivation for our study,” added Shen.

The formal appointment of boards of directors remains largely an insider process. Existing board members and the CEO typically suggest new directors, who are formally nominated by the board's corporate governance committee. Companies often hire consultants to recruit and screen candidates. Directors are elected by a vote of shareholders, but on shareholder ballots there is usually only one candidate for each open position.

Despite the barriers to change, the research team found in its review of other academic studies that in the past 20 years, board diversity has increased along a wide range of characteristics, including gender, ethnicity, age, educational background, area of expertise, executive experience, and industry background.

As an example, the researchers cite the 13-member board of Abbott Laboratories, which in 2005 had two women, one Hispanic, one African-American, three under the age of 55, two with an Ivy League background, seven without a graduate degree, one without a bachelor's degree, two directors without any top executive experience, nine industry outsiders, and at least one from each major functional area of the business.

Past academic research also has tried to identify whether increased board diversity affects board decision-making. According to the W. P. Carey researchers, several earlier studies found that demographically different directors played limited roles in influencing major board decisions, while other studies found that some new and demographically different board members did appear to succeed on boards, serving lengthy tenures and gaining positions on key committees.

Insights from social psychology

To understand how women and minorities function on largely white and male corporate boards, the research team looked to social psychology, a field that includes the study of how people function in groups.

"Because we study boards, we’ve done a lot of research that looks into psychological processes," Hillman said. "At their core, boards are work groups."

Social psychology has identified a phenomenon known as social categorization, which is the process by which people evaluate each other and sort themselves into groups. When a person sees another as belonging to the same social category, these individuals develop a sense of connection and belonging, according to social categorization theory.

Applied to women and minorities joining largely white, male boards of directors, social categorization theory predicts that the newcomers will have difficulties finding acceptance. In this setting, the most obvious traits of the newcomers—gender, race, and ethnicity—will set them apart from the board's larger in-group.

"We know from social psychology that when people are very dissimilar they can be marginalized," Hillman said. "Just putting someone on the board doesn't mean they are going to be listened to or that the benefits of that diverse perspective are going to be actually realized."

On the other hand, the researchers knew that some women and minority directors had succeeded on boards. These demographically different directors had gained appointments as members and chairs of important committees. They also had gained reappointment, and many served multiple terms.

"We understood that individuals who don't have a prototypical background are disadvantaged, but we wanted to know why some demographically different directors were able to succeed," Zhu said.

Looking beyond race and gender

To understand why some new directors succeeded, the researchers again turned to social psychology and the notion of recategorization. This typically occurs when people who belong to a group get to know outsiders a bit better and find that they do have things in common.

“Social psychologically, people tend to have a positive attitude toward others who look similar to them and view them as belonging to the same social group,” Shen said, “This tendency explains to a large degree why corporate boards were traditionally dominated by white males — existing white male directors are more likely to pick white males as new director candidates because of this similarity-attraction tendency.”

Zhu adds that when people see someone who doesn't belong to the same social group, the initial impression is unfavorable. "However, after they spend some time together, one person may discover that the other is similar in some ways,” he said. “In the case of a woman joining a male dominated board of directors, the female and male directors may discover that they went to the same college or that they all have been in the same industry for a long time."

To test whether recategorization was at work on corporate boards, the researchers analyzed comprehensive data on individuals who served on Fortune 500 boards of directors between 1994 and 2006. The data came from a variety of sources, including regulatory filings and proxy statements, as well as Fortune's website, a database compiled by a large consulting firm and published studies by other academic researchers. With this information, the W. P. Carey team was able to identify links between board members' demographic traits and the success of non-traditional members on boards.

The study found that women and minorities tended to be more successful on boards if they shared some attributes with incumbent board members, including educational background, job function and industry background. In such instances, the demographically different directors were more likely to win re-election to the board and to gain positions on important board committees.

"We found that recategorization helps minority directors to get ahead in corporate America," Zhu said. "People who are different from traditional directors can still play important roles on boards. This is good for their careers and it is good news to people who care about social equality in America."

To learn whether demographically different directors influenced the actions of companies, the W. P. Carey researchers examined the relationship between CEO compensation and the presence of women and minority directors on boards. They found that in companies with non-traditional board members, CEO pay was sharply reduced.

In the journal article, the researchers write that "we found that total CEO compensation averaged across three years following new director selections was significantly reduced by the tenure of demographically different directors as board members, committee members, and committee chairs … For example, we found that one year of increase in the tenure of a demographically different director as a major committee chair reduced CEO compensation by $103,000."

Zhu said that this finding is encouraging for people concerned about spiraling CEO pay. "Selecting directors with different backgrounds does help to control CEO compensation," he said.

The findings of this study have important lessons for policy when new members are appointed to boards of directors, according to Hillman. Race, gender, and ethnicity may be the most obvious characteristics to consider when trying to promote diversity, but other traits also need to be considered, she said.

"Given the pressure to increase the numbers of women and ethnic minorities on boards, our research tells us that if they are also selected because of their similarity on dimensions beyond their race and gender, they are going to be much more successful," Hillman said.

Bottom line:

• In countries around the world, pressure is mounting to increase diversity on corporate boards. In some European countries, governments have established gender quotas. In the United States, the push for diversity comes from institutional investors and interest groups.
• A team of W. P. Carey School researchers analyzed 12 years of demographic data on members of Fortune 500 company boards of directors. The researchers sought to understand how the appointment of demographically different directors influences board actions and whether women and minorities find success on boards.
• Women and minorities are more likely to succeed on boards of directors if they share other characteristics of existing board members, the study found. For example, a woman appointed to an all-male board is more likely to gain key committee appointments and be re-elected if she attended the same college or works in the same industry as incumbent members.
• If women and minorities appointed to boards do not share other demographic traits with existing directors, they are more likely to be marginalized in their roles, according to the researchers.
• The study found that boards with demographically diverse members are more likely to challenge the authority of CEOs and to curb CEO pay.

Governance Management